Kennett Square, PA, April 4, 2019 – Chatham Financial today announced that it has submitted a letter urging regulators to reconsider a proposed rule that would increase the amount of capital banks have to hold in reserve against derivatives transactions, the Standardized Approach for Calculating the Exposure Amount of Derivative Contracts, commonly known as “SA-CCR”.
In November 2018, the Prudential Regulators — the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency – proposed revisions to SA-CCR’s risk weighting for derivatives with the announced purpose of making them more risk-sensitive and better calibrating them to the markets.
However, these higher capital requirements may unintentionally impact end users, who use derivatives to reduce risks as a result of exposure to fluctuations in interest rates, foreign currency rates, and commodity prices. Some of the potential unintended consequences of SA-CCR could include:
- Higher hedge transaction costs for end-users; banks are likely to have to raise costs to offset the increased capital requirements
- Reduced liquidity and reduced market efficiency, as banks counterparties may exit certain derivatives market rather than comply with the increased capital requirements
- Operational barriers to hedging such as increased cash collateral requirements, as counterparties look to use cash margining in order to reduce potential capital requirements
“Hedging, by its nature, is designed to be risk-reducing,” Christina Norland, the Managing Director for Global Regulatory Solutions at Chatham, said. “If hedging becomes more expensive due to increased capital requirements, it may discourage the use of derivatives to manage risk and, in fact, create unintended market instability. We want to ensure that regulators have effectively analyzed the market impact of these changes on end-users before finalizing SA-CCR.”
Worse yet, the increased capital requirements could lead more dealers to exit derivatives markets.
“Commercial hedging requires liquid, competitively priced markets,” Norland said. “Right now, the five largest dealing institutions are counterparties to 70 percent of all reported swap transactions. Increasing the costs and requirements on financial institutions willing to engage in swaps could further reduce end-users’ ability to find parties to hedge with.”
Without competitive hedging options, companies would face increased exposure to risk from interest rates, foreign currency exchange, and fluctuating commodities prices, which could cause a significant increase in risk and volatility in the broader markets.
Chatham has thus requested that the Regulators reconsider imposing SA-CCR calculations, in their current form, on derivatives transactions and revise the level of risk they are implicitly assigning to hedging.
“Imposing greater capital requirements for hedging implies that hedging is significantly riskier than previously accounted for,” said Eric Juzenas, Director of Global Regulatory Solutions at Chatham, “but there’s nothing to suggest that hedging risks are currently underweighted. Increasing the capital requirements for hedging could create risk rather than reduce it.”
About Chatham Financial
Chatham Financial is an independent financial risk management firm helping clients overcome common yet complex capital markets challenges. Chatham works with over 2,500 clients globally, providing advisory and technology solutions to Corporations, Financial Institutions, Private Equity and Real Estate companies. Since its founding in 1991, Chatham has hedged over $5 trillion notional, helping clients understand and use debt and derivatives as a critical piece of their financial strategy. Chatham is a multiple bottom line firm committed to delivering trust and transparency in the capital markets. Learn more at chathamfinancial.com.
On behalf of Chatham Financial